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Telefonica grabs O2 from under T-Mobile's nose

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It isn't exactly a secret to anybody who has watched the routine visits between O2 directors and Telefonica - the Spanish telecoms giant has been reluctantly courting the former BT subsidiary for a year or more, simply to keep the Spanish Government happy. But now, it has been forced to move by growing interest from Deutsche Telekom, and is spending £17.7bn ($31bn) to buy O2 out under T-Mobile's nose.

The deal, reported this morning, is a triumph for CEO Peter Erskine [left] and will amaze insiders simply by virtue of the amount. The offer of 200 pence per O2 share represents a 22 per cent premium on what O2's share price would suggest - and that price itself is seen as an exaggerated valuation by insiders.

But the price has been driven up by a bidding war, as T-Mobile's parent company became aware that if Telefonica did buy O2, T-Mobile itself would become seen as one of the smaller European operators by investors.

Directors of O2 have been well aware that their chance to cash in their (now-vested) stock options were not going to be achieved if they didn't bail out of the operator before the going gets nasty.

And they were also aware that the Madrid Government was very keen to see Spanish commerce expand into the European Community at a time when most of the normal rivals are suffering from lean times and capital shortages, and are unable to compete.

As recently as six months ago, O2 board members were privately pessimistic about their chances of a deal with Spain. However, they weren't giving up. Several courtship moves were introduced, with the highest profile one being a move towards the i-mode standard developed by DoCoMo, and adopted by Telefonica.

That technology was rolled out earlier this month, to widespread puzzlement. Officially, the technology was justified by technical arguments as well as the need to be part of a bigger community when it comes to buying downloadable content. But it was a necessary prelude to achieving a merger between Spain and the UK.

The problem facing Deutsche Telekom was highlighted in an eWeek.com opinion piece back in late August, which compared O2 to a second-hand family car, being squabbled over by the family.

"Like my father's car, O2 isn't all that valuable in itself," went the analysis. "My father, when he was planning to sell the car, didn't waste his own money on maintenance; as long as the thing passed its basic roadworthiness tests, he felt he'd spent all he needed to. The result was that the car was worth more on paper than it was to the buyer."

On paper, it was a lovely red beast with one careful owner and regularly maintained. In reality, it had high mileage and a history of "bargain" parts like water hoses and filters and brake linings. In short, no investment in the future beyond what was necessary. Similarly, O2 has been making largely cosmetic changes, and not dealt with the basic operational and strategic weaknesses confronting it.

The trouble was that neither T-Mobile nor Telefonica could afford to see the other acquire it.

And T-Mobile's problem is that it is confronted with massive losses, and is focused on reducing red ink to the exclusion of almost all other strategic issues, leaving its parent in charge of negotiations.

The result was that Telefonica found itself forced to move, because even with all the handicaps the Germans were fighting under, they were at last getting closer to a deal.

That simply couldn't be allowed to happen. Result: Telefonica is now making unconvincing claims that it will make money from the purchase of O2. "The group added that the deal would produce "economies of scale" - resulting in cost savings of an estimated €293m (£198.8m) a year by 2008," reported the BBC's web site this morning.

In one sense this is true. Madrid was prepared to spend a lot more to prevent T-Mobile being joined up with O2 - probably with a budget of £25bn if it was forced to. The question of why Erskine and his board at O2 were prepared to settle for £18bn is one we'll hope to explain later this week.

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